Inventory Classification-ABC Analysis

Inventory Classification-ABC
Analysis
The Pareto principle
VILFREDO PARETO (1848-1923)
• 20% of population owns 80% of nations wealth
• 20% of employees cause 80% of problems
• 20% of items accounts for 80% of firms expenditure
Introduction
• An important aspect of managing inventory is to have a way to classify it based on its importance.
All items in the organization are not of equal importance. Some are very important, and others are
less important, The first step in managing inventory is to classify inventory based on its degree of
importance to manage it properly. The tool for this is ABC classification.
• Such classification allows us to give priority to important inventory items and manage those with
care. It also prevents us from wasting precious resources on managing items that are of less
importance.
It is also known as “Always Better Control”
The ABC
The ABC approach states that a company should rate
items from A to C, basing its ratings on the following
rules:
Analysis • A-items are goods which annual consumption
value is the highest; the top 70-80% of the
annual consumption value of the company
typically accounts for only 10-20% of total
inventory items.
The ABC
rules:
• B-items are the interclass items, with a
Analysis medium consumption value; those 15-25% of
annual consumption value typically accounts
for 30% of total inventory items.
The ABC
rules:
• C-items are, on the contrary, items with the
Analysis lowest consumption value; the lower 5% of the
annual consumption value typically accounts
for more than 50% of total inventory items.
ABC Analysis
• Class A
• 5 – 15 % of units
• 70 – 80 % of value
• Class B
• 30 % of units
• 15 % of value
• Class C
• 50 – 60 % of units
• 5 – 10 % of value
The annual consumption value is calculated with the
formula:
The ABC (Annual demand) x (item cost per unit)
Analysis • Through this categorization, the supply manager

can identify inventory hot spots, and separate
them from the rest of the items, especially those
that are numerous but not that profitable.
Steps for the classification of items:
1. Find out the unit cost and the usage of each
The ABC 2.
material over a given period;
Multiply the unit cost by the estimated annual
Analysis 3.
usage to obtain the net value;
List out all the items and arrange them in the
descending value (Annual Value);
Steps for the classification of items:
4. Accumulate value and add up number of items
and calculate percentage on total inventory in
The ABC 5.
value and in number;
Draw a curve of percentage items and
Analysis 6.
percentage value;
Mark off from the curve the rational limits of A,
B and C categories.
Percentage of Percentage value of
items annual usage
Close day to day
Class A items About 20% About 80%
control
Class B items About 30% About 15% Regular review
Class C items About 50% About 5% Infrequent review
ABC analysis
Example 1
Percentage of Percentage value of

items annual usage
Close day to day

Class A items About 20% About 80% control
Class B items About 30% About 15% Regular review
Infrequent
Class C items About 50% About 5%
review
Step 1
Calculate the total spending per year
Item number Unit cost Annual demand Total cost per year
101 5 48,000 240,000
102 11 2,000 22,000
103 15 300 4,500
104 8 800 6,400
105 7 4,800 33,600
106 16 1,200 19,200
107 20 18,000 360,000
108 4 300 1,200
109 9 5,000 45,000
110 12 500 6,000
Total usage 737,900
Total cost per year = Unit cost * total cost per year
Step 2
Calculate the usage of item in total usage
Annual Total cost per Usage as a %
Item number Unit cost
demand year of total usage
101 5 48,000 240,000 32,5%

102 11 2,000 22,000 3%
103 15 300 4,500 0,6%
104 8 800 6,400 0,9%
105 7 4,800 33,600 4,6%
106 16 1,200 19,200 2,6%
107 20 18,000 360,000 48,8%
108 4 300 1,200 0,2%
109 9 5,000 45,000 6,1%
110 12 500 6,000 0,8%
Total usage 737,900 100%
Usage as a % of total usage = usage of item/total usage

Step 3
Sort the items by usage
Cumulati Usage as a
Item Unit Annual Total cost Cumulative %
ve % of % of total
number cost demand per year of total
items usage
107 10% 20 18,000 360,000 48,8% 48,8%
101 20% 5 48,000 240,000 32,5% 81,3%
109 30% 9 5,000 45,000 6,1% 87,4%
105 40% 7 4,800 33,600 4,6% 92%
102 50% 11 2,000 22,000 3,0% 94,9%
106 60% 16 1,200 19,200 2,6% 97,5%
104 70% 8 800 6,400 0,9% 98,4%
110 80% 12 500 6,000 0,8% 99,2%
103 90% 15 300 4,500 0,6% 99,8%
108 100% 4 300 1,200 0,2% 100%
Total
737,900 100%
usage
Step 4
Results of calculation
Percentage of Percentage
Cathegory Items Action
items usage (%)
Close
Class A 107, 101 20% 81,6%
control
109, 105, 102, Regular

Class B 40% 16,2%
106 review
104, 110, 103, Infrequent

Class C 40% 2,5%
108 review
Additional rules for ABC analysis
Cathegory Percentage of items Percentage of usage
Class A items 5-25% 40-80%
Class B items 20–40% 15-40%
Class C items 40-75% 5-20%
A≤B≤C
Each item should receive a treatment corresponding
Inventory to its class:
• A-items should have tight inventory control,
managemen more secured storage areas and better sales
forecasts; reorders should be frequent, with
t policies weekly or even daily reorder; avoiding stock-
outs on A-items is a priority.
Inventory to its class:

• B-items benefit from an intermediate status
managemen between A and C; an important aspect of class

B is the monitoring of potential evolution
toward class A or, in the contrary, toward the
t policies class C.
to its class:
Inventory • Reordering C-items is made less frequently; a

typically inventory policy for C-items consist of
having only 1 unit on hand, and of reordering
managemen only when an actual purchase is made; this
approach leads to stock-out situation after
t policies each purchase which can be an acceptable
situation, as the C-items present both low
demand and higher risk of excessive inventory
costs.
• Based on the critical nature of items.
V-E-D • Applicable to spare parts of equipment, as they do

not follow a predictable demand pattern.
Classification
• Very important in hospital pharmacy.
• V-Vital : Items without which the activities
V-E-D •
will come to a halt.
E-Essential :Items which are likely to cause
Classificatio disruption of the normal activity.
• D-Desirable :In the absence of which the
n (Contd…) hospital work does not get hampered.
F-S-N
• Takes into account the distribution and handling
patterns of items from stores.
Classificatio
• Important when obsolescence is to be controlled.
• F – Fast moving
n
• S – Slow moving
• N – Non moving
Summary
• An important aspect of managing inventory is to have a way to classify it based on its importance.
All items in the organization are not of equal importance. Some are very important, and others are
less important, The first step in managing inventory is to classify inventory based on its degree of
importance to manage it properly. The tool for this is ABC classification.
• In this session you learnt about how to classify inventory based on usage and degree of
importance. There are other methods of classification popular such as VED and FSN classification
based on types of inventory on business objectives
• Such classification allows us to give priority to important inventory items and manage those with
care. It also prevents us from wasting precious resources on managing items that are of less
importance.

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Inventory Classification-ABC

The ABC (Annual demand) x (item cost per unit)

Analysis • Through this categorization, the supply manager

Class B items About 30% About 15% Regular review

Class C items About 50% About 5% Infrequent review

Percentage of Percentage value of

Close day to day

Class B items About 30% About 15% Regular review

101 5 48,000 240,000 32,5%

Usage as a % of total usage = usage of item/total usage

109, 105, 102, Regular

104, 110, 103, Infrequent

Cathegory Percentage of items Percentage of usage

Class A items 5-25% 40-80%

Class B items 20–40% 15-40%

Class C items 40-75% 5-20%

Inventory to its class:

managemen between A and C; an important aspect of class

Inventory • Reordering C-items is made less frequently; a

V-E-D • Applicable to spare parts of equipment, as they do

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